IRS Issues Guidance on Benefit Limits for Underfunded DB Plans

Under the proposed regulations an employer would be permitted to establish a prefunding balance for a plan that represents the accumulation of contributions made for plan years beginning on or after January 1, 2008 that are in excess of the minimum required contributions for those plan years. The regulation explains that for the first effective plan year of a plan, the prefunding balance is initialized at zero dollars and an employer is permitted to elect to add some or all of the excess contributions made to a plan for each plan year to the prefunding balance as of the first day of the next plan year.

However, the proposed regulations would also provide that the prefunding or funding standard carryover balances cannot be used to offset the minimum required contribution for purposes of determining the amount of excess contributions for the year. In addition, the regulations provide that any contribution that is made to avoid the application of a benefit limitation under Section 436 of the Internal Revenue Code is not taken into account in determining the amount of excess contributions.

An employer would be permitted to elect to use some or all of the prefunding balance or funding standard carryover balance to offset the otherwise applicable minimum required contribution for a plan year only if the plan’s prior year funding ratio was at least 80%. The proposed regulations provide a transition rule to determine a plan’s prior year funding ratio for the first effective plan year.

An election to add to the prefunding balance must be made by the plan sponsor by providing written notification of the election to the plan’s enrolled actuary and the plan administrator. The election must be irrevocable when made, must set forth the relevant details of the election, and generally must be made on or before the due date (with extensions) for the filing of the plan’s Form 5500 for the plan year to which the election relates.

In accordance with section 436(c) of the Internal Revenue Code, the proposed regulations provide that a plan satisfies the limitation on plan amendments increasing liability for benefits only if the plan dictates that no amendment to the plan that has the effect of increasing liabilities of the plan by reason of increases in benefits, establishment of new benefits, changing the rate of benefit accrual, or changing the rate at which benefits become nonforfeitable is permitted to take effect if the plan's funded percentage for the plan year is less than 80%.

A plan must provide that, if its funded percentage for a plan year is less than 60%, the plan will not pay any prohibited payment with an annuity starting date that is on or after the applicable section 436 measurement date. If a participant requests such a prohibited distribution, the plan must permit the participant to elect another form of benefit available under the plan or defer payment to a later date.

For plans with a funded percentage for a plan year that is 60% or more but less than 80%, a participant is permitted to elect a prohibited payment only if the present value of the portion of the payment that is greater than the amount of the monthly straight life annuity under the plan (and any social security supplement, if applicable) does not exceed 50% of the present value of the participant's benefits.

The proposed regulations prohibit a plan from paying any prohibited payment with an annuity starting date that is during any period in which the plan sponsor is under bankruptcy until the date on which the enrolled actuary of the plan certifies that the plan is not less than 100% funded.

If a limitation on accelerated benefit payments applies to a plan, the plan sponsor is treated as having made an election to reduce the prefunding balance or funding standard carryover balance by such amount as is necessary for the plan's funding to be at or above the applicable threshold in order for the benefit limitation to no longer apply. However, the deemed reduction can be made only if the prefunding and funding standard carryover balances to be reduced are large enough to avoid the application of the limitation.

The proposed regulations provide for benefit accruals under the plan to resume effective as of the date benefit accruals are no longer restricted. Once the limitation ceases to apply, a participant's benefits will continue to be paid in the form previously elected unless the plan permits the participant to be offered a new election.

The limitations on benefits do not apply to a plan for the first five plan years of the plan, nor do they apply to plans for which benefit accruals are frozen effective September 1, 2005 or later.

The IRS said the regulations on benefit limitations for underfunded DB plans apply to both single employer plans and to multiple employer plans. In the case of a multiple employer plan, the rules under the proposed regulations would be applied separately for each employer under the plan as if each employer maintained a separate plan.

The proposed regulations are here .